Are Tax Credits the Answer for Rising College Tuition?

October 26, 2006

Gerald Prante

Gerald Prante

It has long been a policy of the federal government to try to help families afford college tuition with the help of tax credits and deductions. Now the state of New Mexico wants to emulate the federal program and expand it. From the Roswell Record:

New Mexicans could receive an income tax credit to help offset costs of attending college under a proposal announced Wednesday by Gov. Bill Richardson.

The measure is among several initiatives that Richardson will recommend to the 2007 Legislature to try to make higher education more affordable and accessible to New Mexicans.

It’s estimated that 40,000 taxpayers would qualify for the credit, which would be based on credits the federal government offers for tuition and certain other higher education costs.

The state would offer a credit equal to 25 percent of the federal credit that a taxpayer qualifies to receive. The proposal would provide an average tax savings of $135 per return and cost the state $5.4 million in reduced revenues.

Richardson also said he would urge university and college governing boards to limit tuition increases to no more than 5 percent annually during the next three years. (Full Story)

There are numerous problems with using the income tax code to try to help students with tuition. The first and obvious limitation is that it may not help those at the very bottom of the income ladder, those people that most lawmakers claim they are trying to help. The more and more taxpayers that are thrown off of the tax rolls and thereby have no income tax liability to begin with, the less any non-refundable credit is going to help those at the bottom because if the credit is non-refundable, there is a floor of zero tax liability and this credit cannot push one below that floor. And if lawmakers then suggest making the credit refundable, why not then just have it through a spending program? There is essentially no difference between a refundable tax credit that ends up raising taxes on others and a government spending program that ends up raising taxes on others. Another problem with these credits is that much of it can merely be offset by higher prices set by the tuition-levying university. It is well established that colleges and universities price discriminate when it comes to tuition fees. Not everyone is charged the same amount at a given school. The university will typically try to extract as much surplus from a given student as possible up to the point at which the student will choose a different school or different career path. And how do they know where to set the price? Answer: Ever wonder why they ask for so much information about financial backgrounds on applications? So as long as the university knows that a student was willing to pay a given amount for education without the credit, they can obviously know who is going to take the credit as they obtain numerous tax information from various entities about a person, and thereby raise the tuition on the individual, saving the student little, if any, money in the end.Finally, as Greg Mankiw points out in a recent blog post, the private return to a college education is still very high. Since nearly all of the benefits of a college education are internalized to the individual student, one must ask why is it the government’s role to highly subsidize college education in the first place?

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